Because it is increasingly easy for investment funds to cross national borders, politicians must exercise a degree of fiscal discipline to attract jobs, capital, and entrepreneurs instead of losing them to another country. This is known as "tax competition" and the United States is the world's biggest winner of this process.
America's modest tax burden, combined with privacy laws for foreigners seeking to escape oppressive fiscal systems, has helped attract more that $9 trillion of foreign investments to the U.S. economy. That inflow is a key source of American prosperity because that money is put to work for the nation and produces more jobs, higher standards of living and general prosperity.
Naturally, high-tax nations resent tax competition. European politicians, for instance, get upset when their taxpayers shift their money to low-tax jurisdictions like Switzerland and the United States. They even have a plan - the European Union "Saving Tax Directive" - that would allow them to impose their burdensome tax rates on income earned in places like America.
That is a dangerous idea. In effect, the EU wants U.S. financial institutions to serve as vassal tax collectors for Europe's welfare states. Moreover, the EU is interfering with U.S. tax policy by asking the World Trade Organization to rule that some provisions of the U.S. tax code are impermissible because they create too much tax competition. If implemented, this initiative -- the "Savings Tax Directive" -- would undermine the right of the United States to set its own tax policy.
America should reject those schemes. Unfortunately, some of the bureaucrats at Treasury and the IRS want to help prop up Europe's over-taxed economies. Almost a year ago, the IRS issued a proposed regulation (REG 126100-00) that would force U.S. banks to report the bank deposit interest they pay to nonresident foreigners. The purpose of the regulation is to help foreign governments collect tax on U.S.-source income.
That would be a major mistake. America does not share common interests with high-tax nations. It makes perfect sense for uncompetitive, overtaxed nations to try to set up a tax cartel and slay tax competition. After all, high tax countries suffer from tax evasion, capital flight and brain drain.
Consider France: According to the French tax authority, 25,000 taxpayers -- many of France's most talented workers -- leave France every year for tax reasons. Further, the estimated level of tax evasion is a whopping 17 percent, higher than most developed countries. Numerous studies have also shown that over half of France's underground economy is tax driven, and that tax avoidance is widely practiced. With a tax burden of 45.5 percent of GDP (including a top personal income tax rate of 54 percent and an average value-added tax of 19 percent), it's little wonder.
To prevent more erosion of its tax base, France has two options. First, cut tax rates. That's what the Irish government did in the 1980s, copying "Reaganomics." Ireland's approach was a big success. Ireland now enjoys the second-highest living standards in the EU.
France's second choice is to use international bureaucracies like the EU to undermine tax competition. Not surprising, this was the preferred choice, not only of France, but other high-tax nations like Germany and Sweden. Those regimes want to buttress their tyrannical tax systems by gaining the power to tax income earned outside their borders. That would require a global tax cartel and a systematic elimination of financial privacy.
This tax cartel would have a terrible effect on US economy. A study by the Center for Freedom and Prosperity highlights how international tax harmonization schemes would undermine America's competitive advantage. Much foreign investment is attracted by low tax rates. With few exceptions, the U.S. government does not tax the investment income of foreigners and does not report this income to foreign governments. Low taxes and financial privacy really make the US a tax haven for taxpayers around the world.
If the EU wins, the U.S. economy will lose savings and investment because foreign governments will get the power to tax income earned in the United States. The U.S. economy would suffer at a time when it needs foreign capital the most. At a minimum, the EU tax cartel would drive $1 trillion out of the country. That translates into fewer jobs and lower incomes for Americans. For the sake of American taxpayers, the Bush Administration should reject the EU's "Savings Tax Directive."